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THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - August 19, 2010

As we look at today’s set up for the S&P 500, the range is 37 points or 2.9% (1,062) downside and 0.4% (1,099) upside. 

  • PERFORMANCE ONE DAY: Dow +0.09%, S&P +0.15%, Nasdaq +0.28%, Russell 2000 +0.28%
  • PERFORMANCE MONTH-TO-DATE: Dow (0.48%), S&P (0.68%), Nasdaq (1.73%), Russell (3.51%)
  • PERFORMANCE QUARTER-TO-DATE: Dow +6.56%, S&P +6.16%, Nasdaq +5.05%, Russell +3.05%
  • PERFORMANCE YEAR-TO-DATE: Dow (0.12%), S&P (1.88%), Nasdaq (2.36%), Russell +0.43%
  • ADVANCE/DECLINE LINE: 538 (-1221) Breadth was very negative
  • VOLUME: NYSE - 922.63 (-5.96%) - continues to be light
  • SECTOR PERFORMANCE: Three sectors negative - the safety trade - XLU XLV and XLE
  • MARKET LEADING/LOOSING STOCKS: King Pharma +8.88% and US Steel +4.8%; Safeway -4.52% and Sealed air -3.06%

EQUITY SENTIMENT:

  • VIX - 24.59 +1.07 - up 5 of the last 8 days.
  • SPX PUT/CALL RATIO - 1.92 up from 1.72 moving up for the last two days

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD 18.89 down 3.28%%
  •  3-MONTH T-BILL YIELD .16% down 0.01%
  • YIELD CURVE - 2.12 to 2.15

COMMODITY/GROWTH EXPECTATION:

  • CRB: 269.90 -0.11%
  • Oil: 75.42 -0.46%
  • COPPER:337.05 +0.36% - looking to up 5 of the last 6 days
  • GOLD: 1,231 +0.43% - up 5 straight days - Bullish formation

CURRENCIES:

  • EURO: 1.2875 +0.01% up for the last 3 days
  • DOLLAR: 82.223 -0.01%

 

OVERSEAS MARKETS:

  • ASIA - Most Asian markets moved modestly higher today, encouraged by the move in the USA China closed up 0.81%; Japan up 1.32%
  • EUROPE - European markets trading higher.
  •  EASTERN EUROPE - Trading higher - Czech Republic and Russia leading the way.
  • MIDDLE EAST/AFRICA - Trading higher  - Jordan and the UAE up; Saudi Arabia down 0.66% 
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER


IGT: MAINTAINING GAMING OPS

Gaming operations used to be a fantastic business for IGT.  Now, investment spend is essentially maintenance capex, at best.

 

 

IGT spends about 16-18% of its gaming operations revenues on gaming operations capex.  Since revenues haven’t grown, we’d have to characterize this capex as maintenance.  Maintenance at best, I should say.  We estimate that casino operators should spend 5-7% of revenues on average on maintenance capex.  IGT, on the other hand, is up to 18% on its gaming operations business.  Certainly, IGT’s gaming ops carries higher EBITDA margins, approximately 500-1,000 bps higher.  That’s not enough to offset 3x higher maintenance capex.  Dare we say, that gaming operations is not as good of a business as the casino business?  At least for IGT, that may be true.

 

IGT: MAINTAINING GAMING OPS - IGT1

 

As can be seen in the next chart, capex attributable to gaming operations has been remarkably constant.  The problem is that there is not incremental gross profit on the spend.  In fact, due to the tough macro environment and increased competition from other gaming suppliers, gross profit has been coming down since 2007.  Rolling four quarters gross profit is down $156.1 million or 18.7% from the peak with no corresponding decrease in capex.  Capex actually appears to be creeping up lately.

 

IGT: MAINTAINING GAMING OPS - IGT2

 

We like the 3-5 year outlook for the gaming supply industry but IGT's gaming ops business needs a boost.  The competition continues to get better and IGT remains very reliant on the Wheel line of products.  It is difficult to see how IGT will turn this segment into a grower again.


RESTAURANTS: THE DARLINGS OF THE XLY

One of the first screens we use to identify potential long or shorts is sell-side sentiment versus short interest, which is expressed via the days to cover ratio.

 

Looking at the data since I penned my DUPE (d) Early Look on June 29, 2010, it is clear that the trends for the American consumer are not getting any better.  We are getting closer to 4Q10, which is the quarter in which significant pressure on the consumer should become more evident.   We estimate that consumer discretionary spending could be down as much as 3% in 4Q10.     

 

As of the close yesterday, Consumer Discretionary was the second best performing sector year-to-date and one of only three sectors that is up year-to-date (XLY up 4.9%).  The other two sectors are Industrials (XLI up 7.4%) and Consumer Staples (XLF up 2.1%).   While easy comparisons and “corporate” fiscal austerity have helped the performance of consumer stocks, the best days of this cycle are behind us.

 

Today, the XLY is the best performing index, up 1.4% at the time of writing.  The positive consumer sentiment is being driven by the increase in mortgage applications, following a surge in refinancing.  In theory this should help consumer spending.  Also, restaurant sales trends are looking better with the Knapp-Track showing an increase of +0.9% (Traffic of -1.7%) vs. -8.3% last year; this is the first increase in 26 months.  Of the ten best performing names in the XLY today 6 are retailers.  Expedia is the worst performing stock in the XLY sector. 

 

As a reminder, the DUPE(d) thesis looks like this…

 

Double-Dip:  The housing market and the broader economy are on the precipice of a double dip; housing prices have already started to decline and the economy has slowed significantly quarter-to-quarter in 2Q10.

 

Unemployment:  Weekly Jobless Claims have not shown any material improvement over the past six months.

 

Prices Paid by the Consumer:  While reported inflation by the government looks to be under control, the Hedgeye Inflation Index tells a different story.  The Hedgeye Inflation Index focuses on the part of the economy showing inflation that impacts the consumer, specifically the spread between the prices of things they buy and what they earn.

 

Equity and Real Estate deflation:  We believe that the debasing of any currency (even the Almighty Dollar) ends badly.  A lack of austerity in government policies and our politicians’ aversion to facing facts are not helping the long-term outlook for equities.

 

Looking at the Hedgeye Sector Sentiment Monitor, the street has become more optimistic about the XLY relative to six months ago; sentiment on the XLY stands at 60.01 vs. 56.53 six months ago and 58.9 for the S&P 500. 

 

Within the Consumer Discretionary index, the three most loved sectors are Diversified Consumer, Hotels Restaurant & Leisure and Internet & Catalog Retail.  Narrowing it down further within those sectors, the most loves names are Darden (DRI), McDonald’s (MCD), Starbucks (SBUX), Expedia (EXPE), Amazon (AMZN) and Devry (DV).  Collectively, these stocks have a 16.2% weighting in the index, with MCD representing 7.8%.  YUM brands (YUM) is not quite as loved as the aforementioned names but sentiment is certainly strong versus most consumer discretionary stocks.  News pertaining to YUM today includes KFC franchisees suing over control of the advertising strategy (grilled chicken debacle continues) and Taco Bell is facing another salmonella lawsuit.  In terms of McDonalds, it seems to me that more positive news is on the horizon; beverage momentum looks set to continue against the backdrop of easy year-over-year comps.   

 

Malcolm Knapp released July casual dining same-store sales and traffic data today and the whisper-number was confirmed with same-store sales coming in at 0.9% and traffic decreasing 1.7%.   This was the first month in 26 months that casual diners saw an increase in comps. 

 

RESTAURANTS: THE DARLINGS OF THE XLY - FORMATIONS

 

RESTAURANTS: THE DARLINGS OF THE XLY - time series

 

RESTAURANTS: THE DARLINGS OF THE XLY - three xly subsectors

 

RESTAURANTS: THE DARLINGS OF THE XLY - knapp aug

 

RESTAURANTS: THE DARLINGS OF THE XLY - knapp traffic aug

 

 

Howard Penney

Managing Director


Early Look

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A DEEPER DIVE INTO CONSUMER DISCRETIONARY (XLY)

One of the first screens we use to identify potential long or shorts is sell-side sentiment versus short interest, which is expressed via the days to cover ratio.

 

Looking at the data since I penned my DUPE(d) Early Look on June 29, 2010, it is clear that the trends for the American consumer are not getting any better.  We are getting closer to 4Q10, which is the quarter in which significant pressure on the consumer should become more evident.   We estimate that consumer discretionary spending could be down as much as 3% in 4Q10.     

 

As of the close yesterday, Consumer Discretionary was the second best performing sector year-to-date and one of only three sectors that is up year-to-date (XLY up 4.9%).  The other two sectors are Industrials (XLI up 7.4%) and Consumer Staples (XLF up 2.1%).   While easy comparisons and “corporate” fiscal austerity have helped the performance of consumer stocks, the best days of this cycle are behind us.

 

Today, the XLY is the best performing index, up 1.4% at the time of writing.  The positive consumer sentiment is being driven by the increase in mortgage applications, following a surge in refinancing.  In theory this should help consumer spending.  Also, restaurant sales trends are looking better with the Knapp-Track showing an increase of +0.9% (Traffic of -1.7%) vs. -8.3% last year; this is the first increase in 26 months.  Of the ten best performing names in the XLY today 6 are retailers.  Expedia is the worst performing stock in the XLY sector. 

 

As a reminder, the DUPE(d) thesis looks like this…

 

Double-Dip:  The housing market and the broader economy are on the precipice of a double dip; housing prices have already started to decline and the economy has slowed significantly quarter-to-quarter in 2Q10.

 

Unemployment:  Weekly Jobless Claims have not shown any material improvement over the past six months.

 

Prices Paid by the Consumer:  While reported inflation by the government looks to be under control, the Hedgeye Inflation Index tells a different story.  The Hedgeye Inflation Index focuses on the part of the economy showing inflation that impacts the consumer, specifically the spread between the prices of things they buy and what they earn.

 

Equity and Real Estate deflation:  We believe that the debasing of any currency (even the Almighty Dollar) ends badly.  A lack of austerity in government policies and our politicians’ aversion to facing facts are not helping the long-term outlook for equities.

 

Looking at the Hedgeye Sector Sentiment Monitor, the street has become more optimistic about the XLY relative to six months ago; sentiment on the XLY stands at 60.01 vs. 56.53 six months ago and 58.9 for the S&P 500. 

 

Within the Consumer Discretionary index, the three most loved sectors are Diversified Consumer, Hotels Restaurant & Leisure and Internet & Catalog Retail.  Narrowing it down further within those sectors, the most loves names are Darden (DRI), McDonald’s (MCD), Starbucks (SBUX), Expedia (EXPE), Amazon (AMZN) and Devry (DV).  Collectively, these stocks have a 16.2% weighting in the index, with MCD representing 7.8%.

 

Howard Penney

Managing Director

 

A DEEPER DIVE INTO CONSUMER DISCRETIONARY (XLY) - FORMATIONS

 

A DEEPER DIVE INTO CONSUMER DISCRETIONARY (XLY) - time series

 

A DEEPER DIVE INTO CONSUMER DISCRETIONARY (XLY) - three xly subsectors


CHART: HOUSING SUMMIT OFFERS EARLY GLIMPSE...

This chart was extracted from Josh Steiner's "HOUSING SUMMIT OFFERS EARLY GLIMPSE OF WHAT MAY COME - STARTS & PERMITS SHOW CONTINUED WEAKNESS" post, yesterday.

 

 

 

CHART: HOUSING SUMMIT OFFERS EARLY GLIMPSE... - Screen shot 2010 08 18 at 9.57.11 AM

 


China: The Great Shift Forward Part II

Conclusion: China’s decision to open up its bond market to foreign investors is likely a major catalyst for widespread internationalization of the yuan. Furthermore, we believe this decision has major implications across asset classes globally over the next 10-20 years.

 

Yesterday, we published a note on the intermediate-to-long term outlook for the Chinese consumer, and within that note, we briefly touched on China’s policy announcement to open up its interbank bond market to qualified foreign institutional investors.  The key takeaways were: a) to accelerate capital flows from abroad by opening up its domestic securities market and b) to make its currency more attractive to foreign central banks by broadening its use globally. Traditionally, trade has been the main way for foreign holders of yuan to return money to China. By opening up its $2.1 trillion interbank bond market, China is now creating new avenues for foreign investors to invest in China.

 

We believe this decision has major implications across asset classes globally, particularly as it relates to the dollar, commodities, and U.S. corporate and government debt over the next 10-20 years. But before we get into key takeaways at it relates to investment opportunities, allow me to briefly summarize the reforms China is putting in place: 

  • China will let foreign financial institutions invest yuan holdings in China’s interbank bond market. As of the end of July, 97 foreign financial institutions including Goldman Sachs and JP Morgan Chase have received approvals from the securities regulator for investment in local currency bonds and equities.
  • Expanding upon a program started with Hong Kong in June ’09, China will open up cross-border yuan settlement to foreign central banks and clearing banks.
  • Further proposals are out to allow foreign investors to win quotas to invest in China’s yuan-denominated A-shares.
  • Shanghai is reported to be considering foreign investment in yuan-denominated private equity and venture capital funds. 

Combined, these reforms are significant, as it expands yuan transactions beyond just trade settlements. By granting foreign institutional investors greater access to investment opportunities, China is likely to spur global demand for yuan-denominated assets, ranging from securities to savings deposits. Furthermore, we believe that with this increased demand outlook, the yuan will receive incremental upward pressure over time, as popularity and investor comfort grows.

 

From an international FX reserves perspective, we believe this news is also bullish for the yuan from both an appreciation standpoint and from a diversification standpoint. As investor confidence grows, so should the confidence of foreign central bankers as it relates to holding yuan-denominated assets. In July, China agreed to a three-year currency swap with Singapore worth 150 billion yuan in addition to the 650 billion yuan of outstanding swap agreements with Indonesia, Malaysia, South Korea, Hong Kong, Argentina, and Belarus.

 

So what does this all mean as it relates to investing? First, we believe this is likely to be a catalyst that accelerates a likely secular up-trend in the yuan’s FX rate. We believe in the yuan as a percentage of international FX reserves will grow substantially over the next decade or two as foreign central banks diversify their FX exposure away from U.S. dollars.  The latest data from the IMF supports our view that the U.S. dollar as a percentage of international FX reserves is mired in a secular down-trend that is not likely to end anytime soon. After falling from 71.5% in 1999 to 62.2% in 2009, the dollar continued its decline in 1Q10, dropping to 61.5% of global FX reserves. China has been leading the charge away from the U.S. dollar: in June it reduced its holdings of U.S. Treasuries by the most ever on a monthly basis, favoring Japanese government and Korean treasury bonds of late (+$20.1 billion and +$2.45 billion, respectively Jan-June). China’s KTB holdings grew 111% Y/Y in Jan-June period and the country is on pace to buy roughly 4 trillion won of KTB’s by year-end.

 

We are at the start of what looks to be a secular shift among global investors away from a low-growth, low-interest rate environment in the U.S. and towards high growth, high(er) interest rate environments in parts of Asia – particularly in the Indonesia, Singapore, Thailand, Malaysia and, of course, China. Malaysia today posted a +8.9% 2Q10 Y/Y GDP growth figure and raised guidance for the full year – citing a pickup in domestic growth in spite of slowing growth in advanced economies. Contrast that with TGT’s top line miss and soft guidance from this morning, and you can see clear as day that the world is changing and that capital will continue to chase yield either through growth or high interest rates.

 

Lastly, we feel that the Chinese economy will benefit from increased access to foreign capital. As growth slows in the Western economies, any investment within China catered towards producing goods for a Western consumer will slow. The broadening of China’s capital markets may ultimately serve to direct investment towards China’s domestic industries where development is needed in order to accommodate its growing consumer base. On the margin, this is a bullish catalyst for the Chinese consumer and, as a side-effect, bullish for the goods they will need (agricultural commodities, automobiles, electronics, etc.). Obviously, these structural changes won’t be fully developed in the near term, so we’ll continue to manage risk throughout the lengthy, long term ascent of the Chinese consumer.

 

Darius Dale

Analyst

 

China: The Great Shift Forward Part II - 1


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.57%
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